Industry Benchmark Performance
The average performance of the benchmark indices, up 5.56% for this year, isn’t reflected in the hedge fund performance, which is barely profitable, but then, we don’t know the July numbers yet. Our programs had generally good returns in July, so we expect the industry to be positive as well.
Futures added to their year-to-date gains, seen in the CTA benchmarks, although our programs gave back some of their gains. At least it argues for diversification.
Overall, it looks as though stocks will be outperforming futures as of the end of July, when those numbers are posted.
More Forbes Blogs
The latest article is on price shocks, something that has affected all traders. It looks at the effects of the British vote and shows how past shocks have been resolved. You can find all of Mr Kaufman’s articles at
Another article has appeared in Modern Trader and another one is in the pipeline. You can address any questions to email@example.com.
July Overview: Very Good for the Major Index Markets
A mixed month, with the Equity Trend program gaining nicely, Equity Divergence posting small losses, Equity Timing good, and Futures giving back some of their gains.
The major equity ETFs, shown below from the beginning of this year, have gone straight up since the British vote, something that no one expected – and probably the reason why it’s happened.
First It’s Good, Then It’s Bad, Then It’s Good
The drop in energy prices, along with the drop in energy-related stocks, has been a boon for trading. But then energy stocks rallied, even though crude oil only thought about rallying, as shown in the chart below. Energy stocks, as seen by the XLE ETF, seem to adjust to lower prices and then perform well, hence the rally from 2008 through nearly the end of 2014. It may only be reflecting the bull market in stocks, which can be interpreted as positive for energy, but we would have thought that margins would be smaller resulting in smaller earnings. Our logic must have a flaw. Now we see another drop in crude oil and a comparable drop in the XLE. Does that mean we’re ready for another sustained rally? We’re going to vote against that again. There is some room for profits with crude at $41/bbl, but this must put even more pressure on the energy companies. Combined with uncertainty in Europe and China, prospects of another sustained rally look dismal. But then, the market seems to rally when we least expect it.
The Fallout From “Brexit”
Last month we said it won’t be over until the fat lady sings. She hasn’t yet. Even with rallies in the US and European equity markets, the pound had staggered. That makes sense. The biggest effect will be on trade. Britain will end up paying higher prices for imports and needs to cut new deals for exports. Uncertainty is causing some business deals to be put on hold, and home buyers are in a wait-and-see mode. We’re still looking for another leg down, at least to 1.20. If you know some reason why Brexit is good for the pound, please let us know!
The Cost of Good Returns
Our new Weekly Sector Rotation program is up 11.7% for the year, and seems to be on a good trajectory (see chart below, left). But that hides the volatility. Trading the three “best” sectors lacks real diversification, which is the prime ingredient for volatility. The returns are show by week in the right chart below. While there are some periods of low volatility near the beginning of 2016, swings of 4% in a week are “normal.” Volatility-adjusting your position size is the best way to maximize diversification; we recommend that a relatively smaller investment in a more volatility program is best.
Portfolios Selected by Performance are High Beta
As a reminder, our automatic portfolio selection process uses past performance to select stocks and futures. Markets that are outperforming the averages tend to continue to outperform, but they also have higher volatility than the broad index. Outperformance means that profits on any day are higher, which also means that on a losing day, losses will usually be larger. It’s the basic principle of volatility and risk: you can’t achieve higher returns without higher risk.
Smaller portfolios that are less diverse are more likely to generate higher returns during “good” markets (the ones that work well for the strategy) and larger losses during “bad” markets. More diverse portfolios will have smaller gains and losses. To decide which is best for an investor, you must understand their risk tolerance and their financial well-being.
Trend Strength Index
One measure of market strength is our Trend Strength Index. Our Trend strategy is a composite of many trends, medium term to slow applied to about 250 stocks. When combined, these determine the position size of the current trade. If the faster trends are down but the slower one up, then the position size might be zero. The appearance is that trend positions scale in and out based on the strength of the trend. The Trend Strength Index appears at the bottom of the Trend Stocks All Signals report each day. We’ve tracked it from the beginning of 2014, and the chart below compares it with the SPY. TSI is the Trend Strength Index and SPY is the SPDR ETF. TSI values about zero indicate a positive trend. The range of the TSI is +1 to –1.
Last month we were looking for more weakness following the British vote. That clearly did not happen. The Trend Strength Index remains strong at over 40 with no clear reversal pattern. The S&P has broken out to new highs. In our experience, new highs mean that prices will continue up for now. The only fundamental explanation seems to be the diminished threat to raise interest rates by the Fed. How long can that last?
We offer this Index for those investors who select their own trades rather than following our sample portfolios. Daily Index values are available to subscribers.
Strongest and Most Undervalued Sectors
There are two ways to view sector rotation, trade the strongest expecting them to stay strong, or trade the weakest expecting the business cycle to rotate them to the top. We have both. The Trend Rotation trades the strongest and the Timing Rotation trades the weakest. The Trend program may hold positions for a long time, so it’s possible for two ETFs to be in both programs. For example, XOP (Oil and Gas) can be in a long-term uptrend, but a short-term oversold situation. The new Sector Rotation program also buys the strongest sectors and is reviewed with the Trend Equity Program.
The Trend Sector ETF program buys the 6 strongest sectors of the SPDRs. July started with the following:
Preferred (PFF), Reits (VNQ), Technology (XLK), Staples (XLP), Utilities (XLU), and Oil & Gas Exploration (XOP)
At the end of July, we had only changed on position, replacing XOP with Metals and Mining, XME. We now hold:
Preferred (PFF), Reits (VNQ), Technology (XLK), Staples (XLP), Utilities (XLU), and Metals & Mining (XME)
The Timing Program buys 4 ETFs that are undervalued with respect to SPY, in expectation of rotation. As of the beginning of July we held only one position:
At the end of July we had closed out XLB and were heavily long the Energy markets:
Preferred (PFF), Oil & Gas Equipment (XES), Energy (XLE), Oil & Gas Exploration (XOP)
When an ETF appears in both the Trend and Timing programs, it means that market is very strong but is in a short-term retracement.
A Standing Note on Short Sales
Note that the “All Signals” reports show short sales in stocks and ETFs, even though short positions are not executed in the portfolios. Our review of using inverse ETFs to hedge stocks during a decline showed that downturns in the stock market are most often short-lived and it is difficult to capture those moves with trend systems. This confirms our approach to the Timing systems, which hedges up to 50% of the long stock risk using multiple trends. In the long run, returns from the hedges are net losses; however, during 2008 the gains were welcomed and reduced losses. In any correction we prefer paying for risk insurance, even without the expectation of a net gain.
Portfolio Methodology in Brief
All of the programs, stocks, ETFs, and futures, use the same basic portfolio technology. They all exploit the persistence of performance, that is, they seek those markets with good long-term and short-term returns, rank them, then choose the best, subject to liquidity, an existing current signal, with limitations on how many can be chosen from each sector. If there are not enough stocks or futures markets that satisfy all the conditions, then the portfolio holds fewer assets. In general, these portfolios are high beta, showing higher returns and higher risk, but have had a history of consistently out-performing the broad market index in all traditional measures.
PERFORMANCE BY GROUP
NOTE that the charts show below represent performance “tracking,” that is, the oldest results are simulated but the newer returns are the systematic daily performance added day by day. Any changes to the strategies do not affect the past performance, unless noted.
Groups DE1 and WE1: Daily and Weekly Trend Program for Stocks and ETFs
The Trend program seeks long-term directional changes in markets and the portfolios choose stocks and ETFs that have realized profitable performance over many years combined with good short-term returns.
A solid gain for all Trend Equity portfolios except the smallest 10 stock, which had a fractional loss. This month saw some very big one-day moves, not only in Facebook, but in natural resources (CLF). These were offset by losses in many of the energy stocks, even as XLE looks strong. Both equity programs are hovering at the top of their NAVs
The ETF programs also had good returns and now show signs of breaking out of the doldrums.
All the Weekly programs posted very nice gains and are well ahead for the year. The smallest 10-stock portfolio (below left) shows the most positive overall performance, moving to new highs steadily. The 30-stock portfolio is turning up, but has had its gains diluted by diversification. That works for you when prices decline, but can work against you in cases like this.
The Weekly ETF program had a good month and shows signs of life. We think it’s overdue for a period of profits, but we’ll need to wait to find the answer.
Big returns this month continue a very volatile profile, as we previewed earlier in this report. As we start this month the program is moving into housing, with Home Builders (XHB) and materials (XLB), plus Metals & Mining (XME). It’s shedding Energy (XLE) and Utilities (XLU). A little more success will push the NAVs to new highs.
Group DE2: Divergence Program for Stocks and ETFs
The Divergence program looks for patterns where price and momentum diverge, then takes a position in anticipation of the pattern resolving itself in a predictable direction, often the way prices had moved before the period of uncertainty.
Considering the fractional losses in all portfolios this month, the Divergence program appears the most stable. The larger 30-stock portfolio continues to hold near highs, while the smaller portfolio has underperformed. This is a case where divergence has been a benefit.
The ETF program is still doing well, with only a fractional loss this month. It is up 3.73% for the year on low volatility.
Group DE3: Timing Program for Stocks and ETF Rotation
The Timing program is a relative-value arbitrage, taking advantage of undervalued stocks relative to its index. Its primary advantage is that it doesn’t depend on market direction for profits, although these portfolios are long-only because they are most often used in retirement accounts. When the broad market index turns down this program hedges part of the portfolio risk. The ETF Rotation program buys undervalued sectors, expecting them to outperform the other sectors over the short-term.
The Timing Program buys undervalued stocks so that it will buy the weakest even in a declining market until that stock shows that it is not expected to rally. Risk is protected with an absolute stop of 15% and also by hedging the broad index.
Good returns in both small and large Timing portfolios, 3.35% and 5.61%, keeps the pattern sideways. We’ll need a few good months in a row to regain the upwards trend in NAVs. Meanwhile, the ETF portfolio was mostly unchanged for July.
Groups DF1 and WF1: Daily and Weekly Trend Programs for Futures
Futures allow both high leverage and true diversification. The larger portfolios, such as $1million, are diversified into both commodities and world index and interest rate markets, in addition to foreign exchange. Its performance is not expected to track the U.S. stock market and is a hedge in every sense because it is uncorrelated. As the portfolio becomes more diversified its returns are more stable.
The leverage available in futures markets allows us to manage the risk in the portfolio, something not possible to the same degree with stocks. This portfolio targets 14% volatility. Investors interested in lower leverage can simply scale all positions equally in proportion to their volatility preference. Note that these portfolios do not trade Asian futures, which we believe are more difficult for U.S. investors to execute.
Using the same strategy and portfolio logic, the Weekly Trend Program for Futures has the added smoothing resulting from looking only at Friday prices. While it will show a larger loss when the trend actually turns, most price moves are varying degrees of noise which this method can overlook.
Please read the report describing our revised portfolio allocation methodology. It can be found in the drop-down menu under “Articles.”
A give-back of 2-3% in futures following last month’s big gains. It still leaves the year-to-date up from 9% to 14.5%, the best of our portfolios and far ahead of the CTA benchmarks. The Weekly Futures portfolios lost less but had also made less last month. They remain up from 3% to 6%. It is interesting that the smallest daily portfolio has the lowest returns while the smallest weekly portfolio has the highest of its group. It indicates that the best performers are also the most volatile.
Group DF2: Daily Divergence Portfolio for Futures
Small gains in all futures portfolios erases some of the losses for the year. The program is showing more volatility than usual, but then the markets are giving it cause.
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